Warning on 'unusually high' asset prices

Josephine Moulds

Asset prices are rising to levels not seen since before the financial crisis despite continuing long-term risks to the markets, the Bank for International Settlements (BIS) has warned.

The warning should ring alarm bells across the world as the Swiss-based bank can claim to be one of the few organisations that saw the financial crash coming.

In its quarterly report, the bank said: ‘‘Unusually, equity and fixed income gains coincided with a weakening of the global economic outlook. In the past, falling growth forecasts have usually been associated with rising expected default rates and higher bond yields.’’

It noted that equity prices had risen even as the outlook for companies deteriorated. Companies’ earnings expectations have dropped and ‘‘an unusually high proportion of firms warned that future profits could fall short of analysts’ forecasts’’.

The bank said investors were taking on more risk for lower returns – driving prices higher – in the hunt for returns in a world where central banks are keeping interest rates at record-low levels. ‘‘Numerous bond investors said that they felt less well compensated for risk than in the past, but that they had little alternative with rates on many bank deposits close to zero and the supply of other low-risk investments in decline.’’

In some cases that has caused asset prices to reach levels that no longer reflected the risk involved. ‘‘Some asset prices appeared highly valued in a historical context relative to indicators of their riskiness,’’ it said.

Advertisement

The bank cited the prices of risky corporate bonds, which have reached levels comparable with those of late 2007, even though the default rate on these bonds is running at 3 per cent, while it was closer to 1 per cent in late 2007.

Companies and governments have taken advantage of this trend by borrowing more over the past three months. In particular the bank noticed ‘‘disproportionate increases in sub-investment grade issuance’’.

The BIS said the market rally was a result of stimulus measures implemented by central banks around the world, in particular the US Federal Reserve, which said in September it would keep injecting money into the economy until the jobs market had ‘‘substantially improved’’. The bank said the markets were also reacting to the receding risk of a breakup of the eurozone and news that suggests China has avoided a sharp landing.

But it warned that the risk of a ‘‘fiscal cliff’’ in the US lingered and had possibly increased in recent months. If politicians fail to reach an agreement, the US will be hit with a group of spending cuts and tax hikes that will come into effect in January, which could push the world’s largest economy back into recession.